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One customer who was struggling to meet loan payments told Volkswagen Finance he was going through a difficult time and had tried to take his own life, but the firm showed "a lack of empathy", the Financial Conduct Authority (FCA) said.
Around 110,000 customers will get a share of the £21.5m compensation the FCA said VW Finance must pay for its failures.
The FCA has also fined the firm £5.4m for the behaviour. The company said it had made "significant adjustments" to its business since.
VW Finance added it recognised its shortcomings and apologised for "any detriment caused".
According to the FCA's report, VW Finance failed to engage with customers who were struggling to pay and sent them "templated communications".
Other drivers were charged the cost of taking their cars away and ignored by VW Finance when they tried to discuss repayment options.
The FCA's report was the result of speaking to case studies and analysing VW Finance's processes.
The report cites one man who told the company about his divorce, anxiety and attempts to take his own life, but was treated "sarcastically".
It also refers to a woman who lost her job and had her car taken away and sold at auction after falling behind on the payments, despite offering multiple times to find a repayment arrangement.
After the car was repossessed, she was charged £252 for "sundry debit” and an “adjustment”.
"In actual fact, this was a repossession fee," the FCA said.
VW Finance would have been fined £7.7m, but it received a 30% discount after agreeing with the FCA to solve the issues.
Jane Sydenham, investment director at Rathbones, told BBC Radio 4's Today programme on Tuesday that VW Finance was not alone in its behaviour.
"A lot of finance companies started to find that a lot of customers were falling behind on payments when interest rates quite quickly in 2022 — and some companies did not handle this well," she said.
Meanwhile, Rocio Concha, director of policy and advocacy at consumer group Which?, said VW Finance's repossession of cars without offering alternative options was "particularly concerning".
'We apologise for any detriment caused'
A spokesperson for VW Finance told the BBC: "We recognise our shortcomings in these past cases and have made significant adjustments over recent years to ensure that we are always delivering the right level of service,"
"We are in the process of concluding our remediation efforts as we continue to provide goodwill payments to affected customers and apologise for any detriment caused."
VW Finance is the UK-based finance arm of the wider German car group Volkswagen, which also owns car brands Audi, Skoda, Bentley, Porsche and several others.
This not the only time the FCA has punished a car finance firm for its treatment of vulnerable customers.
In 2020, Moneybarn was told to pay out £30m in compensation to all of its 5,933 customers and hit with a £2.77m fine for its failure to treat drivers fairly or give them clear information.
The FCA said Moneybarn had "failed to allow customers the ability to clear their arrears over a realistic and sustainable period".
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